REITs, Private Equity Look Beyond Core Properties in 2017

By Stuart Eisenberg, Partner, BDO USA

Private equity fund managers are growing bullish on the real estate industry. From a global perspective, PE funds have already raised a combined $237 billion to invest in commercial real estate in 2017, according to Preqin, outpacing the 2016 investment total of $202 billion. With the Federal Reserve expected to introduce marginal, steady interest rate increases in the year ahead, returns for core property types may decline. Investors face steeper competition for office, hotel and multifamily properties, and the dip in returns could lead many fund managers to embrace alternative real estate assets. REITs and private equity real estate funds—commonly touted as alternative investment options—are already sharpening their focus on non-traditional real estate assets.

Single-family rentals (SFR) is one niche area that has already shown hints of growth to come throughout 2017. PE and REIT interest in SFR took off during the housing crisis, with both buying up distressed homes. According to Hoya Capital Real Estate, the SFR sector performed well in 2016, with a 26 percent rate of return. Now that the housing market has stabilized, more fund managers are looking to exit. In a deal that would create the largest SFR REIT to date, private equity giant Blackstone is preparing for an IPO of their SFR portfolio, Invitation Homes, priced at $1.5 billion.

Another increasingly attractive investment option is data warehouses. The explosion of wireless connectivity, cloud computing and data has led to more demand for storage space. An IDC study found that the total amount of stored data is doubling approximately every two years. Data warehouses or data centers are one way investors can capitalize on the network of facilities sustaining the growth of the Internet of Things. This year, data center acquisitions amounted to $1.7 billion, and investment activity is forecasted to ramp up in 2017. Data Center REIT Equinix’s $3.6 billion deal to acquire Verizon’s data center businesses, which includes 24 facilities, is expected to close in early 2017.

In response to President Donald Trump’s pledge to invest heavily in nationwide infrastructure initiatives, PE and REIT fund managers are unsurprisingly bullish on infrastructure. In the president’s first week in office, his administration announced infrastructure projects totaling over $137.5 billion. As PE real estate funds and REITs explore adding infrastructure assets to their portfolio, we may see them leverage a public-private partnership.

Although PE interest in real estate is expected to increase, the bulk of investments this year will likely stem from the larger players. Carlyle Group is in the early stage of fundraising for its eighth real estate fund and is targeting $5 billion in capital. Consistent with the sector-wide trend, Carlyle Group plans to focus on niche property types, specifically senior living and rental properties, for the new fund.

In addition to increased investment in niche properties, PE has also moved into the debt financing space. PE firms and other non-bank lenders raise debt funds, providing loans as an alternative to or in conjunction with traditional banks for construction projects and property renovations that might not have met traditional lenders’ standards. Investing in real estate debt could become a more prevalent strategy for PE firms, particularly in anticipation of the gradual, yet steady, interest rate increases the Federal Reserve has announced.

While PE consistently attracts interest from institutional investors, pension and endowment fund managers have historically had some concerns with REITs’ volatility and ties to the stock market. But as real estate becomes more common among investment portfolios, some institutional investors have started to take a closer look at REITs. South Carolina Retirement System Investment Commission, for example, made their first investment in REITs in 2016, allocating about $728 million. As the types of investors funneling capital into PE and REITs converge, REIT fund managers would be wise to watch how PE interest develops in the sector, and how it could spur more competition for assets.